Credit news rattles investors
Forget fundamentals such as corporate profits and inflation: This week, the most important issue for stock investors is whether the credit market is correcting or headed for a clampdown.
A wave of scary credit news has shaken Wall Street, testing even the most ardent bulls' argument that problems with subprime loans affect a tiny part of the credit market. The seriousness of the problem was clear Friday when the Federal Reserve moved to inject liquidity into the market. "Now, you have the Fed looking more aware of the liquidity crisis," says Jeffrey Gundlach, chief investment officer of TCW Group.
The Fed's move came days after warnings from Bear Stearns, Countrywide Financial and French bank BNP Paribas about the fallout from subprime mortgages. These things, plus bloodletting in parts of the bond markets, namely subprime, are fanning fears that the days of easy money to buy homes, companies and assets, are at an end.
That's a big reason the Dow Jones industrial average has nosedived 5.4 percent in three weeks after piercing 14,000 and setting a record close. The Dow has subjected investors to triple-digit moves in 11 of the past 16 trading sessions and threatens to wipe out the market's gains for the year. The Standard & Poor's' 500 is clinging to a mere 2.5 percent gain this year.
There still is sharp disagreement on how serious the credit problems are. The differing arguments fall into those who think the credit problems are:
- Spreading and widening. The rate on the 3-month LIBOR (London interbank offered rate), a proxy for interest rates for global banks to lend to one another, is up to 5.58 percent from 5.36 percent a month ago, according to Bloomberg.com. That means "nobody wants to lend you money," Gundlach says.
In another troubling sign, the fed funds rate, the rate banks lend money to each other overnight, hit 5.41 percent on Aug. 9, says Brian Sack of Macroeconomic Advisers. When the yield rises above the Fed's target rate, currently at 5.25 percent, it means credit is tightening. Sack says rates on corporate bonds have also risen as investors send prices down and demand higher returns for their risk.
Meanwhile, investors have hammered subprime mortgages. The ABX index, which tracks the subprime market, is down 63 percent from its high, inflicting massive paper losses on any investors or institutions that own them, says Kevin Gould of bond-tracking firm Markit. He says bond investors of all stripes, not just subprime, were too eager to lend money and now are retrenching.
- Correcting but contained. Beyond subprime loans, damage to corporate bond prices has been limited, says Diane Vazza, head of global fixed-income research at S&P. Yields on junk bonds, debt issued by the shakiest companies, have risen as investors demand a better return. But the rise hasn't been devastating, rising to 4.24 percent above the 10-year Treasury yield in August from 2.8 percent in June.
Wells Capital Management's Jim Paulsen says there's no sign yet of a crunch. "Could this evolve into something bigger? Absolutely. The odds are this is more of a pause than the end game."
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